2010 annual economic outlook

8/8/2019 2010 Annual Economic Outlook

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Prepared by

Gary Adams, Vice President, Economic and Policy Analysis

Dale Cougot, Senior Economist

Shawn Boyd, Agricultural Economist

Michelle Huffman, Agricultural Economist


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Summary

With this economic outlook report, NCCeconomists strive to provide information andanalyses that will equip the industry to meet

todays challenges. An overview of keyissues follows in this section with asummary of supply and demand estimatesfor selected countries in Table 1 on page 6.Detailed discussions and data are morethoroughly presented in subsequent sections.

As 2010 begins, the National CottonCouncils economic outlook for the U.S.cotton industry can be succinctly describedas one of recovery. However, before looking

forward, it is important to review past eventsthat have shaped, and in some casesreshaped, the industry. Since 2007, U.S.cotton production has experienced adramatic decline as acres shifted to grainsand soybeans. At a time when cotton priceswere strengthening, the March 2008calamity in the futures market rippledthrough the entire industry and ultimatelycontributed to the demise of severalmerchandizing firms. As 2008 progressed,

the industry faced record high input costs asoil prices soared. To conclude 2008, turmoilin the financial sector led to a collapse inequity markets.

A global recession persisted through muchof 2009 as the world economy contracted by1%. With little confidence in their economicprospects, consumers took a cautiousapproach in their spending, as evidenced bythe reduction in textile and apparel sales.

Coupled with a liquidation of inventories byretailers, world mill use in the 2008marketing year fell by 10.0%, which was thelargest percentage decline since the 1940s.

The lingering effects and uncertainties of theeconomic downturn continue to presentchallenges for the U.S. cotton industry.However, data suggest that the worst of the

storm has been weathered, and prospects forrecovery and growth are replacing the recentconcerns.

Before delving into the specifics of thecotton market outlook, it is important tounderstand the underlying assumptionsregarding government policies and thegeneral economy. For governmentprograms, NCC economists generallyassume no major policy changes unless thereare pending changes that have alreadyreceived government approval. In the UnitedStates, commodity policy is determined by

the provisions of the 2008 Farm Bill. Fortrade agreements of which the U.S. is asignatory, there are no assumed changes for2010.

Policies in other countries also have a directimpact on the U.S. and world cottonmarkets. China is assumed to continue tomanage their import and stock policies in amanner that will support their internal pricesat levels well above world prices. In

addition, reports indicate that China isimplementing increased support levels forgrain production. That could serve to limitthe increase in cotton area for 2010.

In 2008, India announced increases of 35 to40% for their cotton minimum supportprices and held those levels into 2009. Atthe time, those increases moved supportlevels well above world prices and sharplyreduced their competitiveness in world

markets. Although no formal announcementhas been made regarding 2010 supportlevels, the outlook assumes no change fromthe current support levels.

NCC economists rely on outside sources forthe necessary macroeconomic assumptions.As witnessed over the past 18 months,gauging the performance of the general


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economy remains a formidable task, andsubsequently, a significant wildcard in theeconomic outlook. Projections by theInternational Monetary Fund (IMF),released in late January, call for the worldeconomy to expand by 3.9% in 2010, after a

contraction of 0.8% in 2009. This yearseconomic expansion will be followed by4.3% growth in real GDP in 2011. However,the IMF cautions that economic recovery isproceeding differently across the worldseconomies.

Developing countries, particularly those inAsia, are expected to show more robustgrowth, while recovery in developedeconomies will remain sluggish and

dependent on fiscal stimulus packages.Chinas economy leads the way withprojected growth of 10% for 2010. Thisfollows on the heels of an 8.7% expansion in2009. Indias economy is also viewed in afavorable light with expected growth of7.7%. For the United States and the Euroarea, the IMF projects 2010 real GDP toexpand by 2.7% and 1.0%, respectively.Economic forecasters acknowledge thatweak consumer confidence, high

unemployment rates and increased publicdebt lend to the fragile nature of therecovery.

Bearing in mind these policy andmacroeconomic assumptions, NCCsprojections for cotton mill use are a logicalplace to begin the outlook. Projecting worldmill use has always been a difficult task, inpart because of the uncertainty surroundingthe historical data. For example, China, the

worlds largest processor of cotton, does notpublish official estimates of mill use.Instead, analysts must approximate mill usebased on data such as overall yarnproduction. In the current environment,gauging the recovery in mill use after such asharp decline in the 2008 marketing year canprove to be particularly challenging.

For the 2009 marketing year, NCC estimatesworld mill use at 114.6 million bales, 3.1%higher than 2008. However, 2009 mill use isstill well below the peak levels observed inthe 2005 through 2007 marketing years. The2009 estimate is in line with the long-term

trend.

After the downturn in the 2008 marketingyear, an improved outlook for the generaleconomy is supporting the recovery in milluse. Yarn values improved in the latter halfof calendar 2009 as orders improved. Theincrease in yarn prices also allowed mills tobetter accommodate the higher lint prices.Recent expansion in monthly textile tradevalues also support the estimates of

improved mill use. An unknown at this pointis the extent to which the rebound in milluse is due to stronger consumer demand orthe replenishing of pipeline inventories. Forthe 2010 marketing year, world mill use isprojected to grow by 2.3%, reaching 117.3million bales. Again, the growth ispredicated on the continued improvement inthe general economy.

Chinas textile industry was not immune to

the global economic downturn, falling 6.5million bales in the 2008 marketing year.However, prospects have improved for the2009 marketing year with mill use estimatedat 46.8 million bales. Government policiesand incentives under the textile stimulusplan supported their textile industry duringthe worst of the downturn. Recently, exportmarkets have improved, as have theprospects for 2010 mill use. NCC projectsmill use in the 2010 marketing year to reach

48.0 million bales.

The decline in Indias cotton use during the2008 marketing year was not as pronouncedas China, perhaps indicative of India beingless reliant on textile export markets as anoutlet for their production. For the 2009marketing year, Indias mill use is expectedto grow to 18.8 million bales, as compared


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to 17.9 million bales the year earlier. AsIndias economy grows by more than 7%per year, cotton mill use will also expand.For the 2010 marketing year, India isprojected to process 19.3 million bales, or16% of the world total.

For mill use, Pakistan is the third largestcountry behind China and India. Together,the 3 countries account for two-thirds ofworld mill use. In the 2010 marketing year,Pakistans mill use is estimated at 12.5million bales, up from 12.1 million in 2009.In the improving economic environment,countries such as Bangladesh, Indonesia andVietnam will increase their use of cotton.

In the United States, the slowdown in thegeneral economy compounded the pressurethe textile industry has been facing due toimported textile and apparel products. Milluse in the 2008 marketing year fell to 3.6million bales, down 1.0 million bales from2007. Through the first half of the 2009marketing year, the climate has improvedand monthly numbers exceeded year-agovalues. In early calendar 2010, U.S. textilemills are consuming at an annual rate of 3.7

to 3.8 million bales. It is expected thatcalendar 2010 mill use will exceed calendar2009. For marketing years 2009 and 2010,U.S. mill use is estimated at 3.4 millionbales.

With prospects for global cotton demandimproving, will 2010 production respond tomeet the increased use? With planting of theNorthern Hemisphere crops commencing inthe coming weeks, cottons competitiveness

with grains and oilseeds has improved to itsmost favorable position since prior to the2006 season. However, more than relativemarket prices influence acreage decisions.Ultimately, weather, agronomicconsiderations, and government policies canplay a role in farmers decision. Anoverview of the Councils productionoutlook will begin with the United States.

As in past years, the NCCs economicoutlook incorporates the results of theannual planting intentions survey, mailed inmid-December 2009. Results, collectedthrough mid-January, indicate that growerswill plant 10.1 million acres of cotton,

10.3% more than in 2009. With cottonprices trading 20 cents above year-ago levelsand corn and soybean prices essentiallyunchanged from last year, all regions areexpected to increase cotton acres. Thelargest percentage increases in upland areaare reported in the West and the Southeast,with smaller percentage increases in theSouthwest and Mid-South. The recovery incotton area is not limited to upland varietiesas ELS respondents indicate that they will

increase acres as well. State-level estimatesare available in Table 4 on page 48.Improving prices and the commercialavailability of Roundup Flex pima inCalifornia are expected to bring area back toextra-long staple cotton.

However, weather will ultimately determinethe final outcome for U.S. cottonproduction. For all countries, the outlookassumes normal weather patterns and yields

in line with recent trends. For the U.S.,average abandonment and yields produce a2010 crop of 15.5 million bales, comparedto 12.4 million in 2009.

The stronger cotton prices are expected tobring additional acres into productionoutside the United States. However, theexpansion could be less than initiallyanticipated despite world prices trading inthe mid- to upper 70s. A relatively

conservative recovery in area furtherillustrates the tug-of-war occurring as anumber of crops are competing for availableland.

While additional country detail is availablein the later sections of the report, theinternational projections for area andproduction will be summarized by


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examining China, India, other NorthernHemisphere countries and the SouthernHemisphere.

In China, seed cotton prices 50% higher thanyear-ago levels will attract more cotton acres

in 2010. However, the expansion could beless than originally expected as increasedgovernment support will keep some acres ingrains. Cotton area is expected to increaseby approximately 5% above the 2009 level.Assuming trend yields, Chinas cottonproduction is estimated at 33.8 million bales,1.8 million bales above 2009.

Dramatic improvements in yields, coupledwith expanded area, have allowed India to

more than double cotton production inrecent years. In 2009, India devoted morethan 25 million acres to cotton and harvesteda crop of 23.5 million bales. A strongermarket and the certainty of the highersupport prices contributed to the increasedarea. For 2010, cotton is again expected tocompete for available land, but concernsabout food security will dampen furtherexpansion in cotton area. With areaprojected just 1.8% higher, an expected

rebound in 2010 cotton yields is the primaryfactor behind the projected production of25.4 million bales.

The remaining Northern Hemispherecountries (excluding China, India and theU.S.) accounted for 25.2 million acres in2009. Major producers included Pakistan,Central Asia, and West Africa. Prior to2007, the remaining Northern Hemispherecountries accounted for more than 30

million acres of cotton. However, acombination of lower cotton prices andcompetition from grain crops reduced areain each of the last 3 years. In fact, over thepast decade, cotton area in these countrieshas closely tracked relative prices. Based oncurrent price signals, 2010 cotton area in thisregion is expected to increase by 8.4%.

Production is projected at 29.7 million bales,compared to 26.2 million in 2009.

In the Southern Hemisphere, which isprimarily Brazil, Argentina and Australia,plantings for 2010 will commence in the

latter half of the year. The resurgence incotton prices is expected to induceadditional acres and production. Across theSouthern Hemisphere, production isestimated at 9.5 million bales, up from 8.6million in 2009.

With reduced area and lower yields, worldcotton production for the 2009 marketingyear fell to 102.7 million bales, representingthe smallest crop since 2003. For the 2010

marketing year, the combined results of theregional and country-level projectionsgenerate a world crop of 113.9 million bales.While an 11-million bale rebound inproduction is substantial, the expected cropfalls short of mill use at 117.3 million bales.

After falling sharply in the 2008 marketingyear, world cotton trade for the 2009 seasonis increasing to 34.2 million bales. The U.S.remains the largest exporter with 11.6

million bales for the 2009 marketing year.However, it should be noted that the U.S.share of world trade is sharply lower in thecurrent marketing year as Indias exportsrebounded from the low 2008 level. Bothworld trade and U.S. exports are projected toincrease in the 2010 marketing year. Withworld trade at 35.6 million bales and U.S.exports at 12.1 million bales, the U.S. tradeshare remains at 34%. India, Uzbekistan andWest Africa are projected to increase

exports as their production recovers.

China remains the largest cotton importerwith 9.3 million bales of imports in the 2009marketing year. Given the projections formill use and production, Chinas cottonimports are estimated at 10.9 million balesfor the 2010 marketing year. Imports byBangladesh, Indonesia and Vietnam are


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projected to increase as mill use expands. Incotton-producing countries such as Pakistan,Turkey and Mexico, larger cotton crops willdiminish their import requirements in the2010 marketing year.

An overview of the stocks and pricesituation will conclude this summary of the2010 outlook. After seven months of the2009 marketing year, it is increasingly clearthat global cotton stocks will see their firstsubstantial decline since the 2002 marketingyear. The estimated decline of 9.4 millionbales will be the largest single-yeardrawdown since 1986. Mill use of 114.6million bales and ending stocks of 51.5million bales results in a stocks-to-use ratio

of 45.0%.

In the U.S., ending stocks are projected tofall to 3.7 million bales by the end of the2009 marketing year. This would be thelowest stocks since the 2003 marketing yearand represents a dramatic change from the10 million bales of stocks just 2 yearsearlier.

For the 2010 marketing year, U.S. stocks are

projected to remain at 3.7 million bales as

the combination of 3.4 million bales of milluse and 12.1 million bales of exports are inline with the projected crop of 15.5 millionbales.

Globally, 2010 stocks are expected to

decline by 900 thousand bales, bringing thestocks-to-use ratio down to 43.2%. It is alsoimportant to note the decline in Chinasstocks. For the current marketing year,stocks are estimated to fall to 17.8 millionbales, down 3 million bales from theprevious year. For the 2010 marketing year,stocks are projected to fall to 16.9 millionbales, giving a stocks-to-use ratio of 35.2%.

Cotton prices gained momentum in the latter

half of 2009 as the balance sheet tighteneddue to reduced expectations for 2009production. Prices also found support in animproved general economy and a weakerU.S. $. For 2010, cottons balance sheetremains supportive of prices as worldproduction is projected to fall short ofconsumption. However, the outlook is notwithout risks and uncertainties, particularlygiven the fragile nature of themacroeconomic recovery.


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Table 1 - Balance Sheet for Selected Countries & Regions

09/10 10/11 09/10 10/11

World China *

Production 102.71 113.87 Production 32.00 33.77

Mill Use 114.57 117.26 Mill Use 46.75 48.03

Trade 34.22 35.56 Net Exports -9.23 -10.84

Ending Stocks 51.52 50.62 Ending Stocks 17.84 16.92

United States India


Mill Use 3.42 3.41 Mill Use 18.76 19.30

Net Exports 11.61 12.09 Net Exports 5.97 6.52


Mexico Pakistan


Mill Use 1.90 1.91 Mill Use 12.10 12.52

Net Exports -1.40 -1.35 Net Exports -2.26 -2.21


Brazil Indonesia


Mill Use 4.20 4.28 Mill Use 2.05 2.11

Net Exports 1.90 1.88 Net Exports -2.06 -2.11


Turkey Vietnam


Mill Use 5.09 5.18 Mill Use 1.35 1.45

Net Exports -3.17 -2.86 Net Exports -1.35 -1.44


West Africa Bangladesh


Mill Use 0.19 0.18 Mill Use 4.00 4.24

Net Exports 2.26 2.44 Net Exports -4.00 -4.19


Uzbekistan Australia


Mill Use 1.00 1.01 Mill Use 0.04 0.04

Net Exports 3.99 4.15 Net Exports 1.70 1.82


* Balance sheet assumes Unaccounted of -2.5 million bales in 09/10 and 10/11.

(Million Bales) (Million Bales)


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U.S. and World EconomyThe IMF reported in a special January 26threlease that the global economy, battered bytwo years of crisis, is recovering faster thanpreviously anticipated, with world growthbouncing back from negative territory in2009 to a forecasted growth of 3.9% thisyear and 4.3% in 2011. Growth is sparkedby a rebuilding of corporate inventories, andthe unexpected strength of U.S.consumption has contributed to a rebound inconfidence. Furthermore, inflation isexpected to remain contained. But, highunemployment rates, rising public debt, and,in some countries, weak household balancesheets present further challenges to therecovery.

Ending 2009 on a positive note, heightenedconsumer sentiment has brought investorsback into the market in the U.S. and abroad.Equity markets are expected to continue todeliver good news in 2010, with resultsdriven by three catalysts. First, corporateearnings are showed positive signs for thefourth quarter of 2009 and should continueinto 2010. Second, economic growth in the

U.S. and around the world is once againexpanding close to historical levels. Third,investors still have significant holdings ofcash and bonds. Any advance in theirsentiment would bring additional capital intothe markets supporting the future growth.According to Morningstar, from Marchthrough November, investors pulled $13billion dollars out of U.S. stock funds andplaced $239 billion in bond funds, implyingthere is plenty of capital on the sidelines.

After a rough 2009, the global economylooks to be recovering from the financialcrisis. It must be highlighted that growth isstill largely supported by stimulus measuresput in place by numerous countries aroundthe world. Now these entities face the

daunting task of withdrawing thesemeasures and risk negative impacts.

The Consumer Sentiment Index is a tooldesigned by the University of MichigansSurvey Research Center to gauge the moodof the American consumer with regards tothe economy. According to this index, theAmerican consumers confidence reboundedto 72.5 in December 2009 and averaged 66.3for the year, after hitting a record 28-yearlow of 55.3 in November 2008 (Figure 1).Further improvement occurred this year withJanuary up to 72.8.

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Consumer Sentiment Index

Survey Research Center: Reuters/University of Michigan

Figure 1 - Consumer Sentiment Index

Looking further into 2010, consumerconfidence faces several hurdles with onebeing unemployment close to a 26-year highand projected to average 10% this year.With consumer spending accounting for70% of the U.S. economy, any advance inconfidence will depend largely on sustained

job growth that has not yet materialized.Consumers currently are leery to fullyembrace the current growth in the economicfigures as they worry about job losses, highunemployment, rising foreclosures, highenergy costs and tight credit conditions.


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U.S. Gross Domestic ProductAs determined by the Bureau of EconomicAnalysis, the U.S. 2009 third quarter realGross Domestic Product (GDP) expandedby 2.2% (Figure 2) from the second quarter,after experiencing declines in the previous

four quarters of -0.7%, -6.4%, -5.4% and -2.7%, respectively. The upturn is primarilycontributed to changes in personalconsumption expenditures, exports, privateinventory investment and federalgovernment spending. The IMFs U.S.economic projections are improving with2010 growth at to 2.7% and flattening somein 2011 to 2.4%.

Change in U.S. Real GDPPercent

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Actual Quarterly (BEA) Projected Annual (IMF)

Bureau of Economic Analysis and International Monetary Fund

Figure 2 - Change in U.S. Real GDPExpectations for 2010 are improving asevidenced by the recent, faster than expectedimprovements in the financial conditionswhich have abated fears of the U.S.experiencing a 1930s style crash. Just asuncertainty sent the markets spiralingdownward, a stable financial marketsentiment could cause a surge in

consumption and investment in bothadvanced and emerging markets. A concernthat weighs on the markets is that higher andmore volatile oil prices could hinder growth.Another factor that must be watched isinflation risk. Central banks may feelcompelled to tighten monetary policy toquell any expected inflation pressure.

Access to credit will continue to encumberspending as the Federal Reserve reportedthat consumer credit decreased at an annualrate of 8.5% in November, revolving creditdecreased at an annual rate of 18.5%, andnon-revolving credit decreased at an annual

rate of 3.0%.

U.S. household consumption declinedsharply in late 2008, against the backdrop ofa deepening financial crisis. Personalconsumption expenditures, which hadpeaked above 95% of disposable personalincome in 2005, fell below 92% by thesecond quarter of 2009. This decline brokethe trend of steady increases in the U.S.consumption rate since the 1980s (Figure 3).

Change in U.S. Real PersonalConsumption Expenditures

Percent Change from Previous Period

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03 04 05 06 07 08 09

Total Durable Goods

Figure 3 - Change in U.S. Real Personal

Consumption Expenditures

Both business and residential investment fellto extraordinarily low levels in response tothe previous overbuilding of the housingstock and the falloff in demand for goodsand services. U.S. private investment hasbeen on the defensive since 2005 and

bottomed out mid-2009 as a diminishinghousing market restricted credit lines andeliminated housing wealth. A sharp recoveryoccurred in residential investment thesecond half of 2009 as consumers tookadvantage of deep discounts (Figure 4).


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Change in U.S. RealPrivate Investment

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Total Residential

Figure 4 - Change in U.S. Real Private Investment

There are several negative factors that willhave lasting effects on U.S. consumptionand private investment beyond theimmediate crisis. In the near future, assetprices and household wealth are not likely toreturn to their pre-crisis highs. Creditconditions are likely to remain tighter thanin the past decade, reflecting a renewedappreciation of risks and the decline inwealthincluding housing wealth whichtends to recover very slowly. However,perceived uncertainty facing householdscould remain high longer than manyeconomists expect, given the anemic pace ofrecovery, slow job creation and lingeringconcerns of a double dip recession. Thedrastic 2008 surge in the uncertainty willhave a lasting effect on consumption andwealth.

U.S. EmploymentThe U.S. work force continued its steadycontraction that has been ongoing over thelast several years, bottoming out at 58.4% in

October (Figure 5). In November 2009,employment edged up to 58.5% of the U.S.civilian population.

Civilian Employment

Percent of Population

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Figure 5 - Civilian Employment

Employment in manufacturing jobs steadilydeclined to a low of 11.6 million inDecember 2009 (Figure 6). The averagemonthly decline for the second half of 2009was -41,000 jobs, much lower than the firsthalf of the year at -171,000. Since therecession began, manufacturing employmenthas fallen by 2.1 million; three-fourths ofthis drop occurred in the durable goodscomponent.

Manufacturing EmploymentMillion

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Figure 6 - Manufacturing Employment

Both the December 2009 number forunemployedpersons, at 15.3 million, andthe unemployment rate, at 10.0%, wereunchanged from the previous month. At thestart of the recession in December 2007, thenumber of unemployed persons was 7.7million, and the unemployment rate wasonly 5.0% (Figure 7). Most sources


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conclude that the high rate of unemploymentfor 2009 will be maintained through most of2010. Respondents to the Livingston Surveyin December projects the unemploymentrate for June 2010 at 10.3% and starting amodest recovery to 9.9% by December

2010. The Congressional Budget Office(CBO) notes that even though GDP began togrow in the second half of 2009, theunemployment rate may well take over ayear before it subsides. Their estimate for2010 is at 10.1%, waning slightly in 2011 to9.5%.

Civilian Unemployment RatePercent

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Figure 7 - Civilian Unemployment Rate

Even though financial markets are in a betterstate than they were a year ago, some issuesremain. With that noted, consumers andbusinesses will likely remain cautious,resulting in a slow employment recovery.

U.S. Housing MarketThe housing industry is a key barometer ofthe well-being of the economy. With thetightening of credit and new lending rules,

this sector of the economy will remainfragile for the foreseeable future. Newhousing starts hit a low and bounced, butbottomed in April before stabilizing for theremainder of the year. Housing starts forDecember 2009 were at a seasonallyadjusted annual rate of 557,000 at roughlythe same level as December 2008 (Figure 8).The CBO estimates that there were roughly

2.5 million excess vacant housing units, onaverage during the second half of 2009.

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Housing S tarts Housing Compl etions

U.S. New Residential Construction

U.S. Census Bureau News, January2010

Figure 8 - U.S. New Residential Construction

New single family building permits droppedsharply through the first quarter of 2009 to ahistorical low of 498,000 units and thenshowed some recovery over the course ofthe year with December 2009 at 653,000(Figure 9). Since late 2008, housing permitsand housing under construction have trackedclosely with the other, demonstrating thedistress builders are encountering inobtaining financing. One bright spot camewith the latest release reporting December2010 building permits jumped almost 11%from the prior month.

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U.S. Housing Permits

U.S. Census Bureau News, January 2010Figure 9 - U.S. Housing Permits

Over the past year, seasonally adjustedhome prices fell 3.8% between the 3

rd


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quarter of 2008 and the 3rd

quarter of 2009,according to the Federal Housing FinanceAgency. The agency tracks prices on homespurchased with loans backed by Fannie Maeand Freddie Mac. On a positive note,housing prices broke through during the

third quarter of 2009 as the quarterlyannualized appreciation was up 1% after 8straight declining quarters.

Since 2008, the Treasury has spent morethan $112 billion to assist in shoring upFannie Mae and Freddie Mac, with furthersupport from the Federal Reserve of $1trillion-plus to purchase mortgage backedsecurities since the start of 2009. Additionalefforts came from the Home Affordable

Modification Program and the tax credit forfirst time home-buyers. These governmentactions provided some support throughoutthe year as average home prices showedsome recovery during the second half of theyear.

The relief offered by the Federal Reserve,which is intended to make home buyingmore affordable and prop up the housingmarket, is scheduled to run out of funds in

the spring of 2010. The average rate on aU.S. 30-year fixed mortgage rate in mid-January 2010 is 5.06%, slightly above therecord low in December at 4.71% (Figure10).

Percent

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30-Year Mortgage Rate

Freddie Macs Weekly Primary M ortgage SurveyFigure 10 - 30-Year Mortgage Rate

For the week ending January 15, total homeloan applications rose by 9.1%, marking thethird straight week of increases. In manycases, borrowers scrambling to takeadvantage of low borrowing cost and taxincentives before they expire. Despite the

incentives for new buyers, over 71% of themortgage applications are for refinancing.

Foreclosures reached record filings of near 3million households in 2009. In other words,roughly 1 out of every 45 homes was indefault. As bad as the numbers were, theycould have been worse if it had not been fordelays in processing delinquent loans. Inspite of the 21% increase in filings, only871,086 were actually repossessed, up just

1% from 2008.

Nonresidential real estate conditionsremained soft across most of the U.S., whilethe nonresidential construction activity wasgenerally weak.

Some experts fear the housing sector willflatten or even fall during the first half of2010. One main concern is the massivesupply of delinquent loans looming over the

housing market, many of which will end upin foreclosure in 2010. In addition,adjustable rate mortgages across some350,000 borrowers will hit their amortizingpoint. These loans will carry a highermonthly mortgage payment compared to thecurrent level, which might not even coverthe interest.

Federal Reserve BoardThe Federal Reserve controls the three tools

of monetary policy -- open marketoperations, the discount rate, and reserverequirements. The Board of Governors ofthe Federal Reserve System is responsiblefor the discount rate and reserverequirements, and the Federal Open MarketCommittee is responsible for open marketoperations. Primarily, the federal fund rate is


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the tool for influencing the economy theinterest rate that banks charge each other forovernight loans. Over the course of the year,the fed fund rate averaged 0.16% and startedthe 2010 year at 0.09% (Figure 11).

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Effective Fed Funds Rate

Figure 11 - Federal Funds Rate

Combining the various factors likely toinfluence the path of economic activity in2010, including the outlook for financialmarkets, it is expected that the economicrecovery will continue at a moderate pace.As the year progresses, it is anticipated thatimprovements in financial markets, creditconditions, and business sales will reinforceimproved prospects for 2011. Under thecurrent conditions, it appears warranted thatthe federal fund rate will stay at theseexceptional low levels for an extendedperiod.

Federal Budget SituationThe severe economic downturn and nearlyunprecedented turmoil in the financialsystems over the past two years, combinedwith federal policies implemented inresponse to those conditions, have causeddeficits to climb dramatically.

The Congressional Budget Office (CBO)estimates for fiscal year 2010 that federalspending will total $3.5 trillion and revenuewill only reach $2.2 trillion (Figure 12),resulting in a deficit of $1.3 trillion. This is

just $65 billion less than 2009s shortfalland more than three times the size of thedeficit recorded in 2008.

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Projected U.S. Federal Budget

Congressional Budget Office, January 2010

Figure 12 - Projected U.S. Federal Budget

CBOs projected federal budget deficit of$1.3 trillion for fiscal year 2010 is slightlysmaller than the previous year at $1.4 trillion(Figure 13), or as a % of GDP, at 9.2% and9.9%, respectively. Last years deficitrepresented the largest share of GDP sincethe end of World War II, and the deficitexpected for 2010 would be the secondlargest.

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Figure 13 - U.S. Federal Budget Surplus

CBO estimates that 2010 outlays under theTroubled Assets Relief Program (TARP)will fall by $218 billion. In addition, netspending on federal deposit insurance isexpected to drop by $27 billion, and


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although the housing sector remains weak,outlays for Fannie Mae and Freddie Macwill be lower as well. However, spending inother areas is expected to rise. In particular,the spending under the American Recoveryand Reinvestment Act (ARRA) will grow by

$112 billion. Furthermore, unemploymentcompensation is expected to continuegrowing from its record 2009 level of$75 billion to $82 billion in 2010.Emergency benefits will boost spending byanother $3 billion, and SupplementalNutrition Assistance Program will rise from$51 billion in 2009 to $60 billion.

Spending for Social Security, Medicare andMedicaid will continue to grow faster than

the economy as a whole, rising by nearly 6%for the three programs combined. Inaddition, outlays for retirement, disability,and education benefits for veterans willgrow by 16%, and all other mandatoryprograms are projected to increase by 6%.

The federal fiscal outlook beyond this yearis daunting with projected deficits averaging$600 billion per year over the 2011 to 2020period. Moreover, the baseline projectionsunderstate the budget deficits that wouldresult under many observers interpretationof current policy efforts as opposed tocurrent law.

Consumer and Producer PriceIndicesInflation acts as a tax on investment byincreasing the cost of equity-financedinvestment and reducing corporate equityvalues. U.S. inflation is commonly measuredby the Consumer Price Index (CPI) and theProducer Price Index (PPI).

Measured by the December-to-Decemberchange, the CPI rose 2.7% in 2009,according to Labor Departmentfigures, wellabove the 0.1% gain in 2008 (Figure 14) andin line with the 10 year average at 2.5%. The2009 December-to-December inflation

reflects changes in the energy index, whichrose 18.2% during 2009, after falling 21.3%in the latter half of 2008. On an annualaverage basis, the CPI declined by 0.4% in2009.

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Figure 14 - Consumer Price Index

In 2009, consumers benefited from loweragricultural commodity prices as the foodindex fell 0.5%, the first December-to-December decline since 1961. The index forfood away from home rose 1.9% while thefood at home index fell 2.4%. Within food athome, all six major grocery food groupsposted declines, after rising in 2008.Excluding food and energy, core consumerannual inflation was moderate at 1.8%, thesame level experienced in 2008.

On a December-to-December basis, the PPIfor all commodities rose in 2009 by 4.4%,which is above pre-recession averageinflation (Figure 15). For the year as awhole, the PPI for all commodities declinedby 2.5%, the largest drop since 1949.


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Percent Change

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Producer Price Index

Figure 15 - Producer Price Index

Looking at the annual average, sluggishdemand that comes with a slow economic

recovery is preventing producers fromraising selling prices. This might give theFederal Reserve a reason to support theeconomy by keeping interest rates near zero.

Energy Prices and SupplyGlobal oil markets should gradually tightenin 2010 and 2011 provided the worldeconomic recovery continues as projected.In 2009, world oil demand declined for thesecond consecutive year, which was the first

back-to-back decline since 1983, Afterbottoming in the middle of 2009, demandbegan to recover as the world economyimproved.

At their December 2009 meeting, theOrganization of the Petroleum ExportingCountries (OPEC) decided to keep currentoil production levels unchanged. AlthoughOPEC faces a global oil market that hasfirmed in response to its production cuts

since last January, the strength anddurability of the global economic recovery isstill uncertain. The Department of EnergysEnergy Information Administration (EIA)expects that annual average OPEC crude oilproduction, which declined by almost 2.2million barrels per day on average in 2009,will increase by an average of 500 thousand

barrels per day through 2011 as global oildemand recovers.

OPEC surplus crude oil production capacity,which averaged 2.8 million barrels per dayduring the 1998-2008 period, will continue

to remain high, with surplus capacityreaching almost 6 million barrels per dayover the next two years. As a result of theslow growth in non-OPEC supplies, OPECsmarket share is projected to increase from40% in 2009 to 42% in 2011. Thecombination of higher market share and therelatively high surplus levels of productioncapacity could lead to a greater influenceover world markets.

Non-OPEC supply increased more than 0.6million barrels per day in 2009, the largestannual increase since 2004. Higherproduction in the United States, Brazil, andthe Former Soviet Union (FSU) were thelargest contributors to this growth. However,little net increase in non-OPEC supply isexpected in the short term. EIA projectsnon-OPEC supply increases of 400,000barrels per day in 2010, but then declines bymore than 100,000 in 2011. The largest

source of growth comes from Brazil, theresult of rising offshore capacity andbiofuels production. However, large declinesin production from the North Sea andMexico are responsible for offsetting thesegains.

In 2009, the West Texas Intermediate (WTI)crude oil prices averaged $62 per barrel.Assuming U.S. real GDP grows by 2.0% in2010 and by 2.7% 2011, while world oil-

consumption-weighted real GDP grows by2.5% and 3.7% in 2010 and 2011,respectively, prices are projected to average$80 and $84 per barrel in 2010 and 2011,respectively(Figure 16).


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Dollars per Barrel

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Figure 16 - WTX Intermediate Crude Oil Price

Retail diesel fuel prices (Figure 17), whichaveraged $2.46 per gallon in 2009, areprojected by EIA to average $2.98 and $3.14per gallon in 2010 and 2011, respectively.The expected recovery in the consumptionof diesel fuel in the United States, as well asgrowth in distillate fuel usage abroad shouldstrengthen refining margins.

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Figure 17 - Retail Diesel Fuel Price

High natural gas storage levels, combined

with enhanced domestic productioncapabilities and slow consumption growth,are expected to keep prices from risingdramatically in the next two years. TheHenry Hub spot price averaged $4.06 perthousand cubic foot (Mcf) in 2009 (Figure18). Current spot prices are forecast toaverage $5.36 in 2010 and $6.12 in 2011.

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Figure 18 - Henry Hub Natural Gas Price

In 2009, U.S. natural gas productionexpanded by 3.7%, despite a 59% decline inthe working natural gas rig count fromSeptember 2008 to July 2009. Production in2010 is projected to decline 3.0% due tosteep declines from initial production atnewly drilled wells and the lagged effect ofreduced drilling activity. EIA expectsmarketed production to increase by 1.3% in2011 with growth in production from thelower-48 non-Gulf of Mexico (GOM) fields.

U.S. Equity Markets

As financial turmoil continued into 2009,global equity markets were on a rollercoaster as panic stricken investors took stepsto protect against large losses. From January1 through March 9, 2009, the Dow JonesIndustrials Average (Dow) declined 27.5%,setting a low for the year at 6,547. Marketsthen turned as stability in the financial sectorgained some momentum, and a bull markettook over for the remainder of the year,gaining 59% by years end. It was one of thefastest climbs experienced since 1933. TheDow ended 2009 at 10,428, a rise of 15%for the year (Figure 19).


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Monthly Averages

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Figure 19 - Dow Jones Industrials

Rebound in the NASDAQ was slightlylower, finishing the year at 2,269, up 637 or39%. The S&P 500 rose in 9 of the last 10months of the year and bounced off its lowwith a growth of 68%. For the year, it settledat 1,115, increasing 183 points or 20%.

World EconomiesAfter a deep global recession, economicgrowth has turned positive as wide-rangingpublic intervention has supported demandand lowered uncertainty and systematic riskin financial markets. The recovery could be

hindered as governments withdraw theirsupport. In addition, households thatsuffered severe asset price declines willcontinue to rebuild savings while strugglingwith high unemployment.

According to the IMF, world real GDPdeclined 0.8% in 2009, compared to 3.0%growth in 2008. The latest forecast call for2010 growth to reach 3.9% (Figure 20),similar to pre-recession levels. A gradual

improvement is projected for 2011 withgrowth of 4.3%. Economic activity inadvanced economies contracted by 3.2% in2009, after positive growth of 0.5% in 2008.This marks the first annual contraction in thepostwar period. Emerging and developingeconomies grew by just 2.1% in 2009, wellbelow historical growth rates. For 2010,

growth is expected to recover to 6.0%, withfurther expansion of 6.3% in 2011.

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Figure 20 - World Real GDP Growth

Chinas economic growth slowed in both2008 and 2009, but still reached a veryrespectable 9.6% and 8.7% over the 2-yearperiod (Figure 21). IMF projects Chinas2010 GDP growth rate will recover to10.0%, and in 2011, to 9.7%. Recovery inChina is being fueled by extensive fiscal andmonetary policy stimuli and a rebound in theglobal manufacturing cycle. Anothercontributing factor has been inventoryrebuilding as firms replenish the pipelineafter inventories were liquidated in responseto the sharp decline in demand in 2008.

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Figure 21 - China Real GDP Growth

Developing and emerging economies are onthe road to recovery in 2010 (Table 2). In


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general, emerging economies like China,India and Pakistan withstood the financialturmoil much better than expected based onpast experiences.

Table 2 - Selected Economies: Real GDP

Year-Over-Year % Changes2008e 2009e 2010f 2011f

World 3.0 -0.8 3.9 4.3U.S. 0.4 -2.5 2.7 2.4Euro Area 0.6 -3.9 1.0 1.6Japan -1.2 -5.3 1.7 2.2China 9.6 8.7 10.0 9.7India 7.3 5.6 7.7 7.8Russia 5.6 -9.0 3.6 3.4Brazil 5.1 -0.4 4.7 3.7Mexico 1.3 -6.8 4.0 4.7Source: International Monetary Fund, January 2010

Since the first quarter of 2009, equitymarkets posted strong gains, corporate riskspreads declined, and spreads in interbankmarkets fell to levels similar to rates thatprevailed prior to the large bank failures inthe U.S. in 2008. Investors are beginning toallocate an increasing amount of funds awayfrom government secure bonds in search ofhigher yields.

Emerging markets, particularly in Asia, are

leading the economic recovery, butadvanced economies are still gaining groundquicker than anticipated. However, therecovery is fragile and growth, particularlyin advanced economies, remains dependenton government stimulus measures.

Asian markets reacted positively throughout2009 with some responding to externaldemand while others focused on internalmatters (Figure 22). Japans Nikkei

underperformed compared to their peers forthe whole of 2009, but the exchange enjoyeda strong December, ending the year up 19%.The Hong Kong Hang Seng market jumped45% from the start of the year, recoupingmost of the losses of 2008. Recently, themarket has pulled back due to fears ofBeijing reining in lending.

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Figure 22 - Asian Stock Indexes

Exchange RatesDuring periods of market uncertainty,

traders sell currencies that are perceivedriskier and place their bets in safe havens.One sign that stability is returning to theglobal economy is an easing of the volatilityin major currency pairs. Now, many tradersturn to a carry-trade strategy as they seek toprofit from the interest rate differentialbetween currencies.

The U.S. dollar enjoyed a short lived rallyagainst the Euro as funds flowed away from

the dollar in the early part of 2009 (Figure23). During this past month, the dollargained some strength, as there has beengrowing concerns in regards to Greecesdeteriorating public finances. Thoseconcerns have triggered one of the worstcrises in the Euro zone since theintroduction of a single currency.


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Figure 23 Euro

In 2009, Japans economy contracted by5.3%, the deepest of any major economy.However, their economy is projected to

recover in 2010, but most likely it willunderperform the U.S. growth expectations.The Japanese yen has found support recentlyacross many of the major currencies as riskaversion spurred demand (Figure 24).

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Figure 24 - Japanese Yen

An overriding trend across most currency

markets played out this past year with astrengthening of the dollar in the firstquarter of the year, followed by a steadydecline. In part, this can be attributed to theelection of a new President and a rathergenerous stimulus package that was passedby Congress. However, as jobs and growthcontinued to deteriorate over the year, so did

confidence for a quick U.S. recovery and thestrength of the dollar. This held true for theBrazilian Real, South Korean Won, IndianRupee and the Indonesian Rupiah (Figures25-29). Only in China and Pakistan did thetrend differ.

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Figure 25 - Brazilian Real

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Figure 26 - South Korean Won


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Figure 27 - Indian Rupee

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Figure 28 - Indonesian Rupiah

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Figure 29 - Pakistani Rupee

Chinas economic rebound from the globaldownturn proved to be more robust than anyother large economy, thanks largely toenormous monetary and fiscal stimulus. In

2009, Chinas real GDP is estimated to havegrown by 10.0%. But many skeptics claimthat their recovery is built on shakyfoundations. The Chinese renminbicontinues its holding pattern against thedollar that first began in mid-2008 (Figure

30). Currently, there are worries that Chinamay tighten monetary policy, which wouldfuel demand for the dollar and likelydampen commodity prices.

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Figure 30 - Chinese Renminbi

The Federal Reserve Board publishes a realexchange rate index comparing the dollar toa weighted average of currencies ofimportant trading partners, excluding majordeveloped economies. Between July 2008and March 2009, the trade weighted indexjumped 21 percentage points and then gaveup half of those gains by the end of 2009(Figure 31).

Boosted by growth in China and otheremerging markets, commodity-backedcurrencies look set to outperform the dollarand euro in the early part of 2010.


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Federal Reserve Board

Figure 31 - Real Exchange Rate Index

Commodity PricesThe Commodity Research Bureau (CRB)

maintains an index of commodity pricemovements. The commodities included inthe index range from traditional U.S.agricultural commodities to heavily tradedinternational products such as cocoa, coffeeand sugar to metals and energy. The index isa combination of arithmetic and geometricaveraging which means its absolute value atany one time is not particularly informative.However, the movement in the index fromany base point can be revealing.

Commodities started 2009 under continuedpressure through the first quarter, beforereversing and climbing modestly throughoutthe year. This was mainly reflective ofmovements in energy prices. Current pricesare still below the 2007 pre-recession levels(Figure 32).

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Figure 32 - Reuters/CRB Futures Index

The U.S. Department of Agriculture(USDA) publishes monthly indices of pricesreceived by farmers. The index of cropprices received was 160 in January 2009with several mid-year movements between146 and 161, before eventually settling inDecember at 152 (Figure 33). Livestockprices began the year fairly flat at 114 beforerising to 118 in December. The cotton priceindex continued its decline into 2009 to alow of 76 and holding in a tight range untilspiking in September to finish the year at 96.

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Figure 33 - Ag Prices Received Index

USDA also publishes monthly indices ofprices paid by farmers for variousproduction inputs. Of particular interest arethe indices for energy related inputs such asdiesel and nitrogen fertilizer. The index ofdiesel prices paid fell to a near-time low of


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192 in March 2009 and has since reboundedback to 253, which is near the January 2007level (Figure 34). Starting 2009 at 333,nitrogen fertilizer had a modest increase inthe first quarter before it continued decliningto 241 at the end of the year, 46% below

2008 highs. These indices imply thatproducers could face fuel and nitrogenfertilizer costs in 2010 similar to the 2007crop, barring no major disruptions.

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Figure 34 - Ag Prices Paid Index

U.S. Net Farm IncomeThe latest USDA estimates place U.S. net

farm income at $57.0 billion for 2009(Figure 35), a decline of more than $30billion from 2008. The forecast is $6.5billion below the 10-year average of $63.6billion.

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Figure 35 - U.S. Net Farm Income

After being whipsawed in 2008 by highlyvolatile domestic and internationalmacroeconomic forces, the U.S. farm sectordemonstrated it is intertwined with the worldeconomy more than ever. In 2009, cropprices continued to decline. With economicconditions deteriorating worldwide, demandfor exports fell off sharply. This left fewoptions for farmers, forcing them to acceptlower than the prices anticipated when theplanting decision was made. Farm cashreceipts declined by 13% in calendar 2009,with both crops and livestock experiencingdouble digit drops. Large decreases areestimated for the food grains, feed crops,fruits, tree nuts and cotton with slightincreases for oil crops, vegetables andmelons.

USDA estimates that 2009 governmentpayments will increase to a total $12.5billion, a 2% increase from 2008 but 19%below the 5-year average. Direct paymentsand counter-cyclical payments are expectedto total $6.3 billion.


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U.S. Farm and Trade Policy2008 Farm BillThe Food, Conservation, and Energy Act of2008, hereafter referred to as the 2008 Farm

Bill, legislates the provisions of the cottonfarm program for the 2008 through 2012crops. The bill became law in June 2008, butas of early 2010, implementing rules forcertain provisions were still being developedby the Department of Agriculture.

The new farm law maintains the basicstructure of previous farm programs bycontinuing the marketing loan, directpayments, and counter-cyclical payments.

Certain marketing loan provisions forupland cotton were modified to reflectchanges advocated by the cotton industry.Much-needed support was also introducedfor the U.S. textile industry. The 2008 FarmBill establishes a permanent disasterprogram designed to partially coverweather-related losses at the whole-farmlevel. Another new provision is an optionalrevenue-based counter-cyclical program thatproducers can choose as an alternative to the

target price counter-cyclical program. Thenew bill also makes significant changes topayment limits and program eligibilityrequirements.

Base Loan Rates, Marketing Loansand LDPsThe 2008 Farm Bill maintains the uplandcotton base loan rate at 52.00 cents/lb (SeeTable 3 on page 26). The duration of theloan is maintained at nine months from thefirst day of the month following entry.

The following provisions of the uplandcotton marketing loan are effective for the2008-12 crops: Eliminate warehouse location

differentials. Develop loan schedule premiums and

discounts on a 3-year moving average of

spot market information, weighted byregions share of U.S. production.

Eliminate the split in the micronaire

schedule between staple lengths 32 and33. For qualities of cotton in which the leaf

grade is more than one grade above thecolor factor, the premium/discount willbe set equal to the premium/discount ofthe quality with the same color factor butwith a leaf grade that is one better thanthe color factor.

In the calculation of the Adjusted WorldPrice (AWP), which is based on the 5

lowest Far East quotes,o Incorporates a seamless transition

between marketing years such thatcurrent-crop quotes are used throughthe end of the marketing year, ifavailable.

o Adjusts to U.S. location by using theaverage costs to market, includingaverage transportation costs.

o Institutes the Fine CountAdjustment, which can lower theAWP for qualities better than 31-3-35 based on differences in premiumsin the U.S. and international markets.

Storage credits to upland cotton loanrepayment values are maintained for the2008 through 2012 marketing years, butreduced by 10.0% from the 2006 maximumrate for the 2008 through 2011 marketingyears and reduced by 20.0% from the 2006maximum rate beginning with the 2012marketing year. Storage is credited whenAWP is less than the total of the loan rateplus interest plus storage.

Marketing loan gains (MLG) will continueto be payable as the difference between thebase loan rate and AWP when the formerexceeds the latter. For eligible producersthat agree to forego placing upland cotton in


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CCC loan, the marketing loan gain isavailable as a loan deficiency payment(LDP).

The loan rate for ELS cotton is maintainedat 79.77 cents/lb.

Base Acres and Payment YieldsIn general, the upland cotton base acres andpayment yields established by the 2002Farm Bill that were effective September 30,2007, will constitute the base acres andpayment yields for the 2008-12 crops.However, the new law requires adjustmentsto base acres under various circumstances.These include, but are not limited to,adjustments based on the likelihood that

land returns to agricultural use, and changesin the status of a Conservation ReserveProgram (CRP) contract.

For 2009, USDAs preliminary enrollmentreports indicate that 17.60 million acres ofupland cotton base enrolled in the Direct andCounter-cyclical Program (DCP).

Direct PaymentsFor upland cotton, the direct payment is

maintained at 6.67 cents/lb (See Table 3 onpage 26). There is no direct paymentavailable for ELS cotton. For the 2009-11crops, direct payments are paid on 83.3% ofan eligible producers base acres multipliedby payment yield. In 2012, the percentage ofbase acres receiving direct payments isincreased to 85%. Direct payments remaindecoupled from current productiondecisions.

Target PriceFor upland cotton, the 2008 Farm Billauthorizes a target price of 71.25 cents/lb forthe life of the legislation (See Table 3 onpage 26). The current farm bill makes noprovision for a target price for ELS cotton.Target prices for wheat, soybeans and someminor feed grains are increased for the2010-12 crops.

Target prices are used in the calculation ofcounter-cyclical payments (CCP). The CCPrate is determined as: (target price) minus(direct payment) minus (greater of 12-monthmarketing year average price or loan rate).When the sum of the direct payment and the

marketing year average price exceeds thetarget price, the corresponding counter-cyclical payment is zero. Counter-cyclicalpayments are decoupled from production, asare the direct payments. Counter-cyclicalpayments will continue to be made on 85%of base acres and payment yields.

Average Crop Revenue ElectionProgramAs an alternative to the price-based counter-

cyclical program, producers have the optionto elect a revenue-based program beginningwith the 2009 crop.

In return for accepting a 20% reduction indirect payments and 30% reduction in loanrate, producers may make an irrevocableelection to enroll all covered commoditiesand peanuts in a state-level revenue counter-cyclical program, known as the AverageCrop Revenue Election, or ACRE, program.

For producers with qualifying losses, theprogram makes payments on a portion ofplanted acres based on the differencebetween 90% of the product of a stateaverage yield factor times the nationalseasonal average price for the previous 2years for the commodity and the actual staterevenue for the commodity. Producers whochoose not to participate in the ACREprogram beginning in 2009 have the abilityto choose the program in each subsequent

year. However, once an affirmative ACREdecision is made, the producer may notreturn the farm to the target price counter-cyclical program.

Initial enrollment data show just 966 farmswith 30 thousand acres of upland cottonbase chose the ACRE program. Oklahoma


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accounts for 732 of the ACRE farms, withanother 184 farms in Texas.

Producer Agreement Requirementsfor PaymentsFor a producer to be eligible for payments,

they must:1. Comply with conservation requirements;2. Comply with planting flexibility

requirements;3. Maintain land in an agricultural or

conserving use;4. Submit annual acreage reports.

Payment Limitations and EligibilityRequirementsTaking effect with the 2009 crop, the 2008

Farm Bill includes a number of changes inboth limits and eligibility.

The farm bill eliminates the limit onmarketing loan gains and LDPs, which was$75,000 prior to 2009. The limits on directpayments and counter-cyclical payments are$40,000 and $65,000, respectively. Forproducers with some or all of their farmsenrolled in the ACRE program, the limit ondirect payments is reduced from $40,000 by

an amount equal to the 20% reduction indirect payments. The limit on revenue-basedACRE payments is increased from $65,000by the amount of the reduction in the DPlimit.

The 2008 Farm Bill eliminates the 3-entityrule, and direct attribution is applied to allcommodity program payments. The rules forspouse eligibility were enhanced such thatan actively engaged spouse is automatically

credited with making a significantcontribution of labor and management.

While the farm bill statute included nochanges in the determination of thoseactively engaged in farming, USDA,through the rule-making process, institutedsignificant new restrictions that all membersof a farming entity make a regular,

identifiable, documentable, separate anddistinct contribution of active personal laboror active personal management.

Income means tests for commodity andconservation payment eligibility are more

restrictive under the 2008 Farm Bill. If anentity or individual earns an average of morethan $500,000 in adjusted non-farm incomeduring the 3 years prior to the yearproceeding the applicable year, theindividual or entity is ineligible for anycommodity program payments for the year(example: for 2009 crop, use average of2005, 2006 and 2007).

If an individual or entity earns an average of

more than $750,000 in adjusted farm incomeduring the 3 years prior to year precedingthe applicable year, the individual or entityis ineligible for direct payments for the year.The definition of farm income is alsoexpanded to include other sources of incomederived from a farming or agriculturalenterprise.

For conservation payments, if during 3 yearsprior to the year preceding the applicable

year, an individual or entity earned anaverage of more than $1.0 million inadjusted non-farm income or more than $1.0million in adjusted gross income (if less than66s is from farming, ranching orforestry), that individual or entity isineligible for conservation programpayments for the year (but does not apply toeasement programs).

In addition, USDA has placed unnecessary

payment limits on the ConservationStewardship Program (CSP). The 2008 FarmLaw clearly establishes a five-year paymentlimit of $200,000 per person or legalentity for all contracts entered into duringany five-year period. Without basis,USDA has instituted an overly-restrictivelimit of $40,000 per year on CSPparticipants and a five-year limit of


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$200,000 per contract, regardless of thenumber of participants associated with thecontract.

Cotton Import ProvisionsWhen the average U.S. quote in the

international market exceeds the prevailingworld market price for 4 consecutive weeks,a Special Import Quota equal to 1 weeksmill use is triggered. Cotton imported underthis quota must be purchased within 3months and enter the U.S. within 6 months.Imports under this quota cannot exceed 10weeks of mill use in a marketing year.

Authority for Global Import Quotas is alsoextended by the current farm law. Whenever

the base quality spot price for a monthexceeds 130% of the average for theprevious 36 months, a limited global importquota equal to 3 weeks of mill use must beopened for a 3-month period. Limited globalquota periods cannot overlap, nor can alimited global quota be established if aspecial import quota is already in effect.

ELS Cotton CompetitivenessProvisions

Competitiveness payments for eligibledomestic users and exporters of AmericanPima cotton are continued for the 2008-12crops. The payment rate reflects thedifference between the American Pimaquote in the Far Eastern market (APFE) andthe lowest foreign quote in the Far East(LFQ), adjusted for quality. If the APFEquote exceeds the LFQ for 4 consecutiveweeks and the LFQ is less than 134% of thebase loan rate, then the payment rate equals

the difference between the APFE and theLFQ in the fourth week of the 4-week

period.

Economic Assistance to Users ofUpland CottonBeginning August 1, 2008 through July 31,2012, the Secretary is required to make a

payment to domestic users of 4 cents/lb forall upland cotton consumed by U.S. textilemills. Beginning August 1, 2012, the rate isadjusted to 3 cents/lb.

Payments must be used for purposesspecified in the 2008 Farm Bill and includeacquisition, construction, installation,modernization, development, conversion, orexpansion of land, plant buildings,equipment, facilities, or machinery; such

capital expenditures must be directlyattributable and certified by the user for thepurpose of manufacturing eligible uplandcotton into eligible cotton products in theUnited States.

Export ProgramsTitle III of the 2008 Farm Bill makes anumber of changes to trade promotion andfacilitation programs important to the U.S.cotton industry. Specifically, the law repeals

the Intermediate Export Credit GuaranteeProgram (GSM-103) and the Supplier CreditGuarantee Program. The Export CreditGuarantee Program (GSM-102) isauthorized with $4 billion in creditguarantees and $40 million in budgetauthority.

The Market Access Program (MAP) and theForeign Market Development (FMD)Program are funded at annual amounts of

$200 million and $34.5 million,respectively.


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Table 3 - Support Rates in the 2008 Farm Bill

Loan Rate Target Price Direct Payment

08-09 10-12 08-09 10-12 08-12

Upland Cotton (lb) 0.5200 0.5200 0.7125 0.7125 0.0667

ELS Cotton (lb) 0.7977 0.7977 NA NA NARice (cwt) 6.50 6.50 10.50 10.50 2.35

Wheat (bu) 2.75 2.94 3.92 4.17 0.52

Barley (bu) 1.85 1.95 2.24 2.63 0.24

Oats (bu) 1.33 1.39 1.44 1.79 0.024

Corn (bu) 1.95 1.95 2.63 2.63 0.28

Sorghum (bu) 1.95 1.95 2.57 2.63 0.35

Soybeans (bu) 5.00 5.00 5.80 6.00 0.44

Peanuts (ton) 355.00 355.00 495.00 495.00 36.00

Other Oilseeds (cwt) 9.30 10.09 10.10 12.68 0.80

ACRE Program Provisions

ACRE State ProgramGuarantee

90% * (5-yr Olympic rolling avg state yield per plantedacre) * (2-yr rolling avg of national average market price);Starting in 2010, the ACRE guarantee shall not increase ordecrease by more than 10% from the preceding marketingyear. Provisions to allow separate guarantees for irrigatedand non-irrigated land under certain conditions.

Actual State Revenue Actual state yield per planted acre * higher of national avg.market price and 70% of marketing loan rate.

Actual Farm RevenueActual farm yield * higher of national MYA price and 70%of marketing loan rate.

Farm ACRE BenchmarkRevenue

(5-yr Olympic rolling avg farm yield) * (2-yr rolling avgnational market price) + per-acre crop insurance premium

Payment Rate per AcreLesser of (ACRE State Program Guarantee Actual StateRevenue) or 25% of ACRE State Program Guarantee

Individual FarmerPayments

Payment Rate * Payment Acres * (5-yr Olympic rolling avgfarm yield / 5-yr Olympic rolling avg state yield)


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World Trade OrganizationTrade issues continue to command theattention of the U.S. cotton industry. In theWorld Trade Organization (WTO), therewas little progress in the ongoing Doha tradenegotiations, but the trade dispute with

Brazil moved through the arbitration phase.

Doha Trade NegotiationsThe U.S. cotton industry has consistentlydelivered the message that a Dohaagreement must balance gains in marketaccess with the reductions imposed ondomestic support. Unfortunately, the currenttext, which was originally tabled by WTODirector General Pascal Lamy in July 2008,does not contain the necessary balance

between domestic support and marketaccess. The NCC continues to convey thismessage to U.S. negotiators and have beenencouraged that U.S. officials are carryingthat message to other countries. The WTOsnegotiating schedule for 2010 remainsunclear.

Brazil Trade DisputeIn August 2009, a WTO Arbitration Panelruled that Brazil could seek retaliation for

the U.S.s failure to comply with an earlierpanel regarding the export credit guaranteeprograms and certain provisions of theupland cotton farm program.

The Panel developed distinct awards that areultimately summed together for the purposeof determining whether or not Brazil isallowed to seek retaliation beyond trade ingoods. The Panel adopted a formulaapproach to retaliation authority applicable

to the export credit guarantee program (alsoknown as the GSM program) and stated thatthe formula would authorize $147.4 millionin retaliation authority for the GSM programbased on 2006 data. The Panel alsoauthorized $147.3 million (a fixed amount)in retaliation authority for cotton -- far lessthan Brazil had requested. The Panel also

adopted a formula approach concerning so-called "cross-retaliation" that requires theparties to sum the two awards outlinedabove and determine whether that sumexceeds a "trigger" level which wouldauthorize Brazil to cross-retaliate against

intellectual property rights of U.S.companies.

In November, Brazil published a list of 222items being considered for additional duties.Brazil has previously implied that it will beentitled to over $650 million in retaliationfor the export credit guarantee program,bringing total countermeasures of more than$800 million. However, no decision onretaliation is expected before February.

The NCC has consistently argued that thePanels ruling does not appreciate themarket and policy changes for U.S. cottonsince 2005. U.S. cotton production in 2009was more than 45% below the 2005 level.The U.S. share of world cotton productionhas declined to 12% of total world cottonproduction an 8 percentage point declinesince 2005 and the lowest since 1983.

Textile Trade IssuesTextile trade policy continues to have asubstantial impact on the U.S. textileindustry, both in terms of opportunities toexport textile and the pressures brought tobear by imported textiles and apparel. 2009brought relatively few changes for U.S.textile trade policy. Agreements have beennegotiated with Panama, Colombia andSouth Korea, but those agreements arecurrently stalled in the approval process..

China

Following their entry into the WTO in late2001, China has dramatically expanded theirrole in world textile trade. China has madefull use of WTO provisions to increase theirtextile imports to the U.S.


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A China-specific safeguard allowed the U.S.and other WTO member countries thatbelieved imports of Chinese-origin textileand apparel products were, due to marketdisruption, threatening to impede the orderlydevelopment of trade in these products to

request consultations with China with a viewto easing or avoiding such marketdisruption. Countries had authority toimpose safeguards through the end of 2008.In addition, the U.S. and China signed abroad bi-lateral agreement on Chinesetextile imports into the U.S. The agreementwent into effect on January 1, 2006 andended on December 31, 2008. In general,U.S. imports of Chinese goods covered bythe agreement were allowed to grow by 10

to 12.5% in 2006, 12.5% in 2007, and 15 to16% in 2008, depending on the item.Furthermore, in 2006, the agreementimposed tighter limits on U.S. imports fromChinas core apparel products. The coreapparel products are cotton knit shirts, MMFknit shirts, woven shirts, cotton trousers,MMF trousers, brassieres and underwear.

The loss of the import restrictions on Chinacame at a time when the U.S. was

experiencing a large downturn in the retailmarket due to the recession. Therefore, theimpact of the expiration of the agreement onthe U.S. was not as apparent as it wouldhave been if quotas were removed at a timewhen the retail market wasnt experiencingsuch a downturn, since this decline caused adecrease in total U.S. textile imports. Evenwith the decline in the U.S. retail market andsubsequent decline in U.S. textile andapparel imports from China in 2008, China

continues to be the largest single importer oftextile and apparel products into the U.S.with a total market share of 45% based ondata through November 2009.

Chinas market share for all U.S. textile andapparel imports increased even more afterthe removal of the quotas at the expense ofmany of the countries with which we have

free trade agreements that encourage the useof U.S. cotton. Looking at U.S. market sharefor agreement versus non-agreementcategories for calendar years 2008 and 2009,Chinas market share of U.S. imports for thecategories that were covered by the

agreement for data through November 2008was just 14% while Western Hemispherecountries (such as the countries of NAFTA,CAFTA, and the Andean) totaled 47% of theU.S. market share (Figure 36). However,Chinas market share for those samecategories surged to 23% for data throughNovember 2009 while Western Hemispherecountries dropped to 40% of the U.S. marketshare.

Market Share of US Textile ImportsU.S.-China Agreement Categories

2008YTD

China

14%

West

Hem.

47%

ther

Asia

27%

ROW

12%

2009YTD

China

23%

West

Hem.

40%

Other

Asia

28%

ROW

9%

Figure 36 - Market Share of U.S. Textile Imports

(U.S.-China Agreement Categories)

While gaining market share in the agreementcategories, China also held steady with theirmarket share for non-agreement categories(Figure 37). Chinas market share for thosetextile and apparel products that were notcovered by the agreement was 55% for datathrough November 2008 as well as for data

through November 2009.


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Market Share of US Textile ImportsNon-Agreement Categories

2008YTD

West

Hem.

1 0%

Other

Asia

1 9%

R OW

16 %

China

55 %

2009YTD

China

55%

West

Hem.10%

Other

Asia20%

ROW

15%

Figure 37 - Market Share of U.S. Textile Imports

(Non-Agreement Categories)

AGOA

The African Growth and Opportunity Act

(AGOA) provides preferential access oftextile and apparel products to the U.S.market for qualifying countries in Africa. In2004, legislation extended AGOA from itsplanned expiration date of 2008 to 2015.Other key provisions of the legislationincluded the extension of authority for theuse of third country fabrics from September2004 to September 2007. Rules-of-originprovisions were amended to allow non-AGOA produced collars and cuffs for

apparel import categories. The folkloreprovision was expanded to allow ethnicfabrics that are made on machines to qualifyfor AGOA duty-free treatment. Thelegislation also included provisions for thedevelopment of sustainable infrastructureand technical assistance, including theassignment of 20 people to sub-SaharanAfrica to assist and advise them on sanitaryand phyto-sanitary standards to meetrequirements for the U.S. market. In 2006,

provisions of AGOA were extended toprovide for use of non-U.S., non-AGOAcomponents through September 2008.However, beginning October 2008, 50% ofthe fabric used in apparel qualifying forpreferential access must be manufactured inAGOA countries. The legislation alsoestablished tax credits for companies with

facilities in AGOA countries or that conductbusiness in AGOA countries.

The AGOA legislation requires an annualdetermination to determine which countriesare eligible to receive benefits under the

trade act. Countries must make continuedprogress toward a market-based economy,rule of law, free trade, and economicpolicies that will reduce poverty, and protectworkers rights. There are now 38 countriesthat are eligible for economic and tradebenefits under AGOA. Of those 38 Sub-Saharan countries, 25 of them are eligible toreceive AGOAs apparel benefits. Seventeenof those countries also qualify for AGOAsprovisions for handloomed and handmade

articles. Four countries qualify for AGOAsethnic printed fabric benefits.

CAFTA-DR

Although first signed by President Bush inAugust 2005, the Dominican Republic-Central America-United States Free TradeAgreement (CAFTA-DR) has beenimplemented in stages as participatingcountries meet their internal approvals. TheCAFTA-DR entered into force for El

Salvador on March 1, 2006, for Hondurasand Nicaragua on April 1, 2006, forGuatemala on July 1, 2006, for theDominican Republic on March 1, 2007 andfor Costa Rica on January 1, 2009.

According to the provisions of the CAFTA-DR agreement, textiles and apparel are duty-free and quota-free immediately if they meetthe agreements yarn-forward rule of origin.This means that only apparel using yarn and

fabric from the U.S., Central America andthe Dominican Republic qualifies for duty-free benefits.

The textile provisions also include a numberof avenues for 3rd-country participation,including cumulation, Tariff PreferenceLevels (TPLs) which authorize the use of aspecified quantity of 3rd country


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components, a fabric-forward rule of originfor certain products and allowances forsingle transformation for a number ofothers. Single transformation means onlyone manufacturing step has to be taken in acountry in order for products made from

components sourced from anywhere toqualify for benefits.

Cumulation is a concept that bringscountries that are not signatories to anagreement into the agreement provided theyare signatories to another trade agreement.The signatories of CAFTA-DR agreed tocumulation with Mexico and Canada forwoven apparel. This allows a limitedamount of inputs from Mexico and Canada

to be used in Central American/Dominicanapparel that will still qualify for duty-freebenefits in the U.S. Cumulation underCAFTA-DR is subject to an annual cap of100 million SME. This cap can grow to 200million SME, but the growth is tied to anincrease in CAFTA-DR trade. Under theoverall cap of 100 million SME, there is a 1million SME cap on wool, 20 million SMEcap on blue denim, and 45 million SME capon cotton and man-made bottom weights.

Mexico and Canada must provide reciprocalbenefits to U.S. and Central Americantextile and apparel exports. Canada andMexico must also agree to strengthenCustoms enforcement measures. TheCAFTA-DR Cumulation provision becameeffective on August 15, 2008. The TPLs forCAFTA-DR cumulation for the period ofJanuary 1, 2009 through December 31, 2009was 100,000,000 SME. During that time,imports applied to this preference level

equaled 1,775,851 SME, implying a 1.8%fill rate. The TPLs for CAFTA-DRcumulation for the period of January 1, 2010through December 31, 2010 is 100,000,000SME.

CAFTA-DR provides Nicaragua with a TPLof 100 million SME which phases out over10 years. CAFTA-DR does not contain

TPLs for El Salvador, Honduras orGuatemala. The TPL for Nicaragua was88,618,262 SME for the 2009 preferenceperiod. During this period, 87,794,027 SMEof imports were applied to this TPL,implying a 99.1% fill rate. This is up slightly

from the 2008 fill rate of 96.7%.

CAFTA-DR provides Costa Rica with TPLsfor certain apparel of wool fabric, tailoredwool apparel, and certain womensswimwear. Combined, these TPLs were1,100,000 SME for the 2009 preferenceperiod.

CAFTA-DR contains a special textilesafeguard which allows the U.S. to impose

tariffs on certain goods when injury occursdue to import surges. A safeguard can notlast more than 3 years for a specific good.The Committee for the Implementation ofTextile Agreements (CITA) applied a textilesafeguard measure on imports of cottonsocks from Honduras in 2008.

The agreement also contains a revised shortsupply process that includes tightertimelines than in earlier short supply

processes, allows items to be deemed inpartial short supply, and provides for itemsto be added to and removed from the shortsupply list.

An amendment regarding pocketing materialbecame effective in August 2008. Under thisCAFTA-DR amendment, material forpockets going into apparel made in theCAFTA region have to be made in the U.S.or CAFTA countries for the product to enter

the U.S. duty free.

Andean Countries

The U.S. Peru free trade agreemententered into force on February 1, 2009.Under the U.S. Peruvian agreement, 80%of U.S. consumer and industrial productexports and two-thirds of U.S. agriculturalexports to Peru were duty-free immediately.


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The textile and apparel provisions are basedon the yarn-forward rule of origin. There areno provisions for TPLs or exceptions to therequirement that qualifying products containcomponents manufactured in the U.S. orPeru. As in NAFTA, a list of components

not manufactured in either country has beendeveloped and only those products may besourced from a third country.

On November 22, 2006, the U.S. Colombia Trade Promotion Agreement wassigned. On June 28, 2007, the United Statesand Colombia signed a Protocol ofAmendment revising the Agreement toreflect the bipartisan consensus on trade ofMay 10, 2007. As of mid-January 2010, the

U.S. Colombia Trade PromotionAgreement was still pending Congressionalapproval.

Under the U.S. Colombia agreement, over80% of U.S. exports of consumer andindustrial products to Colombia will beduty-fr

2010 annual economic outlook

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